By: Austin Colby, CFP®, MBA
When talking about investing or portfolio construction, one of the core philosophies you should learn about is asset allocation.
What is asset allocation? It is an investment strategy that aims to balance the risk and reward by apportioning a portfolio’s assets according to an individual’s goals, risk tolerance and investment horizon. The three main asset classes – equities (stocks), fixed-income (bonds), and cash – have different levels of risk and return, so each will behave differently over time.
In other words, it means that you don’t put all of your eggs in one basket.
The baskets inside your portfolio represent all the various investment markets where you can invest your money. There are so many asset classes available for investment today. Technology has greatly improved the distribution channel of potential investments for the everyday-investor. Beyond the three major asset classes listed above, here is a sampling of others:
Large-cap US stocks
Mid-cap US stocks
Small-cap US stocks
Emerging market stocks
As you can see, there are a lot of baskets in which to put your eggs.
Once we’ve determined which baskets your eggs should be in (20% US stocks, 10% emerging markets…etc.) then the research to find out which are the best eggs begins.
If we determine that your appropriate asset allocation includes seven of those above baskets, based on your time horizon, goals and risk tolerance, then we will research all of the available eggs for those specific baskets. Ideally, you will get each basket filled with one, two or possibly three good eggs.
Because of the natural diversification of using multiple baskets (asset classes) and the various eggs (individual investments) inside each basket, your portfolio is less likely to have massive swings up or down, regardless of how one of those baskets perform. If one or two eggs turn out to be rotten, it doesn’t blow up your whole portfolio. On the flip side, if one or two eggs turn out to be amazing, high-flying performers, it doesn’t mean the entire portfolio will also.
We determine which baskets make sense for you based on your unique, personal financial situation and then pick some good eggs to own. That is a high-quality recipe for long-term portfolio success.
This information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. The information contained in this blog does not purport to be a complete description of the securities, markets, or developments referred to in this material. This information is not intended as a solicitation or an offer to buy or sell any security referred to herein. Investments mentioned may not be suitable for all investors. The material is general in nature. Opinions expressed int he article are those of the author and are not necessarily those of Raymond James. All opinions are as of this date and are subject to change without notice. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Past performance may not be indicative of future results. Diversification and asset allocation do not ensure a profit or protect against a loss. Prior to making an investment decision, please consult with your financial advisor about your individual situation.